Competition among bank regulators.

COPYRIGHT 1999 Federal Reserve Bank of Richmond. This material is published under license from the publisher through the Gale Group, Farmington Hills, Michigan. All inquiries regarding rights or concerns about this content should be directed to Customer Service.

The organization of bank regulation in the United States is somewhat peculiar. Banks answer to an array of regulators, both federal and state. To begin with, a bank can choose a national or a state charter. National banks are regulated by the Office of the Comptroller of the Currency (OCC). State banks are regulated by their home states, as well as by a federal regulator. The Federal Reserve System regulates state-chartered banks that are Federal Reserve members, and the Federal Deposit Insurance Corporation (FDIC) regulates state, nonmember banks. A bank, by its choice of charter and Federal Reserve membership, chooses its regulators. There is a sense, then, in which U.S. federal bank regulators are in competition with each other. How does this competition affect bank regulation in the United States? On the one hand, one might conclude that the need to compete with other agencies would motivate a regulator to perform its tasks as effectively and efficiently as possible. On the other hand, one might argue tha t the desire to attract more clients could drive a regulatory agency to be loose.

Banking is not the only industry in which alternative regulatory agencies compete with one another. Most other instances, however, involve different geographic jurisdictions. For instance, to the extent that environmental regulations vary from state to state, a manufacturer's decision on plant location entails a choice among potential regulators. The stringency of such regulations then has the potential to become one tool by which states compete to attract businesses. One could ask the same question about this competition as is often asked about the interaction among bank regulators. Does competition lead to effective or excessively loose environmental control?

When the effects of the regulated activity, polluting for instance, are predominantly local, geographic regulatory competition, as in the case of state-level environmental rules, is analogous to the jurisdictional competition studied by Tiebout (1956). Tiebout's direct concern was the provision of "local public goods" by local governments funded with local taxes in a setting with a mobile population. His conclusion was that competition in the joint setting of taxes and levels of public goods and services would lead to efficient levels of government expenditures. The same logic applies to local regulation of activities with local effects.

Bank regulation, however, does not have the same geographical limits as some environmental regulation. While state banks are regulated locally by state supervisory agencies, all banks have federal regulators. Further, a bank can change its federal regulator without having to relocate or make any other significant change in its activities. In this environment, does the Tiebout logic of beneficial competition still apply?

This article highlights how the effects of alternative regulatory structures depend on assumptions about such underlying factors as the regulators' objectives, and the way in which regulators' costs are financed. This point can best be made in the context of a model that captures important elements of bank and bank regulator activities. Section 2 presents such a model. The model's emphasis is on the role of bank examinations in assessing the quality of bank assets in the presence of deposit insurance. In the context of this model, an efficient regulatory policy is defined. Possible regulatory outcomes are then studied under alternative assumptions about regulators' preferences regarding banking industry performance and the extent to which deposit insurance and bank examination are integrated activities financed under a consolidated budget constraint. In some cases, regulatory competition leads to efficient policy choices, while in others competition results in inefficient outcomes. Notably, when the financing of regulation and deposit insurance is not integrated, competition among regulators can impose excessive costs on deposit insurance.

1. BACKGROUND

In discussions about rivalry among alternative bank regulators, a common concern is that regulators will "race to the bottom." Each regulator, it is argued, will want to attract as many banks into its constituency as possible. Further, this incentive to attract "client" banks will outweigh the regulators' interest in controlling bank risk-taking incentives. This so-called "competition in laxity" will result in excessive costs to the deposit insurance system. The possibility of a race to the bottom, as discussed by Scott (1977), has partly motivated a number of proposals for the consolidation of federal bank regulation.

The notion that competition might result in excessively lax or otherwise inefficient regulation is not unique to banking. In the general area of corporate governance and the market for corporate control, it has been argued that states compete to be corporations' charter locations by passing laws that inhibit corporate takeovers. Since incumbent managers make location decisions, they might be influenced by laws that protect their incumbency. Karpoff and Malatesta, for instance (1989), report evidence that supports this hypothesis. Similar arguments have been made about local environmental controls when the effects of pollution extend beyond the local area. Local governments and their constituents enjoy the economic benefits of a manufacturer's decision to locate in their area but the environmental cost is shared more widely.

These assertions that regulation results in a "race to the bottom" by economic efficiency standards stand in sharp contrast to Tiebout's notion of beneficial competition. The key difference is seen in the example of environmental controls. Tiebout's result applies when both the costs and the benefits of the pollution-generating activity accrue to the constituents of the local governmental decision maker. Inefficient regulatory choices are more likely to arise when the costs spill over between localities.

The clean dichotomy between beneficial and harmful regulatory competition relies on an additional important assumption involving the governmental decision makers' objectives. In the case of environmental regulation, the assumption is essentially that the local government acts to maximize its constituents' welfare. Other objectives are also possible, however. Stigler (1971) and Peltzman (1976), and the extensive literature that follows their seminal work emphasize the political economy of interest groups as a determining factor in regulatory decisions. Along these lines, one idea that is often voiced is that of "regulatory capture." This term expresses the notion that regulatory actions may be driven more by the interests of the firms in the regulated industry than by considerations of general or consumer welfare. In reference to banking in particular, Kane (1996) has suggested that regulators' self-interest can shape the outcomes of regulation. …

On March 26, 2012, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Commission (the "Agencies") released proposed guidelines on leveraged finance, emphasizing that these guidelines encompass exposure to a leveraged…

WASHINGTON -- The following information was released by the Federal Deposit Insurance Corporation: Good afternoon. Thank you for joining us for today's joint Federal Reserve-FDIC conference on "Mortgages and the Future of Housing Finance." Our goal in organizing this conference was to bring…

Comptroller of the Currency John Dugan said federal regulators have reached an agreement on how to implement the proposed Basel II capital rule's advanced approach and are on track to release a final rule next month. Mr. Dugan acknowledged that his sunny outlook was unusual, considering the…

WASHINGTON -- The following information was released by the Federal Reserve Board: The Federal Reserve Board on Friday appointed the Federal Deposit Insurance Corporation (FDIC) as receiver for Community Banks of Colorado, of Greenwood Village, Colorado, a state-chartered bank and member of the…

At Cengage, privacy is important to us, as such we have a Global Privacy Program in order to comply with regulations that apply to us, our notices, and agreements with our customers.
In order to protect and use data in accordance with these regulations, our polices and notices, we collect the birth year of our users.
For additional questions or concerns please visit www.cengage.com/privacy or contact the Privacy Office, privacy@cengage.com.

Year of birth:

An error has occured, please try submitting again or contact Costumer Service at 1-800-860-9227

After many years of successfully serving the needs of our customers, HighBeam Research is being retired.

You will have full access to the website until the final date. At that time, customers who have remaining time on their accounts will have a pro-rated credit issued to the credit card on file in your account. If you have saved articles, please log in to your account and export or print any that you wish to keep. Saved searches and search alerts cannot be exported.